By Pam Martens and Russ Martens: August 15, 2022 ~
This past Friday, five state-owned companies in China announced that they would apply this month to delist their shares from the New York Stock Exchange. The companies plan to continue trading in Hong Kong and mainland China. The companies include the large oil company Sinopec; China Life Insurance; Aluminum Corporation of China; PetroChina; and Sinopec Shanghai Petrochemical Company. It is highly likely (and long overdue) that more Chinese share delistings on U.S. exchanges will follow.
For the past two decades, China has been stonewalling U.S. regulators over access to the work papers of auditors of publicly traded companies that are based in China but listed on U.S. stock exchanges. China takes the position that these audit work papers hold state secrets and it prohibits audit firms from releasing the documents directly to U.S. regulators, effectively flouting U.S. accounting law.
This untenable situation finally forced the hand of Congress to take a stand in December of 2020. Both houses of Congress unanimously passed legislation called the Holding Foreign Companies Accountable Act. The legislation requires that the Securities and Exchange Commission (SEC) identify companies that are listed in the U.S. which the Public Company Accounting Oversight Board (PCAOB) cannot “inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.”
The legislation also requires the listed companies to provide documentation showing that they are not owned or controlled by a governmental entity. It also requires that the SEC prohibit the trading of the company’s stock in the U.S. if its audits cannot be inspected for three consecutive years.
According to the U.S.-China Economics and Security Review Commission (USCC), an independent U.S. government agency, as of May 5, 2021, “there were 248 Chinese companies listed on these U.S. exchanges with a total market capitalization of $2.1 trillion.” Those exchanges are the New York Stock Exchange, Nasdaq, and NYSE American (formerly the American Stock Exchange).
Some of the U.S. listed Chinese companies had their Initial Public Offerings (IPOs) underwritten by the biggest names on Wall Street, including JPMorgan Chase, Morgan Stanley, Goldman Sachs, and Citigroup, among others. In addition, Wall Street underwriters always have counsel advising them on IPOs – typically from the biggest law firms in the U.S.
Anger over what the Wall Street underwriters and their legal advisors have allowed to get listed on U.S. stock exchanges spilled out in public comment letters filed in connection with the SEC creating a rule to enforce the new legislation. Seven Senators, including John Kennedy, the sponsor of the Holding Foreign Companies Accountable Act, sent a letter to SEC Chair Gary Gensler on July 28, noting the following:
“…many of the largest U.S. underwriters have enthusiastically collected billions in fees and profits from these Chinese firms being listed on U.S. exchanges. Asset managers and index providers similarly profit by including Chinese firms in investment offerings and prominent indexes, including those used by the federal government’s Thrift Savings Plan. These American financial institutions do this, while seemingly looking the other way on transparency, the risk of CCP [Chinese Communist Party] influence, and CCP human rights violations, all to the detriment of the American retail investor and other U.S. interests.”
The American Securities Association, which says its mission is to be “America’s Voice for Main Street Investors,” sent a public comment letter to the SEC on May 5. Below is an excerpt from the letter:
“The ASA largely supports the Rule as adopted because it will inform investors about the level of ownership and control the Chinese government has in listed companies. Just as important, it will reveal the name of each Communist Party official that sits on a company’s board. Given the current focus on governance of public companies, it seems logical for investors to also know about every Chinese Communist Party official who is exerting control over the operations and finances of the Chinese companies listed on both the NASDAQ and the NYSE.”
A preposterous letter came from nine Chinese law professors, who wrote:
“It is extremely unusual that issuers are required to disclose information relating to a specific foreign political party. Such requirement clearly contradicts the market-based principles of U.S. capital markets and the professionalism of U.S. financial regulation, which reflects an inappropriate inclination to over politicize securities regulation.”
That letter might have been less laughable were it not for the fact that actions by the Chinese Communist Party put the share prices of Chinese education stocks trading on U.S. exchanges through a meat grinder last spring and summer. See our report: U.S. Mega Banks Were Sitting on $6.56 Billion of Chinese Education Stocks that China Just Eviscerated.
Another serious problem with some Chinese stocks was the subject of a House hearing last October. Congressman Brad Sherman chairs the House Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets. At a hearing convened on October 26, 2021, Sherman said this:
“We see that China is able to pressure index funds to include Chinese companies but it’s not Chinese companies that are in the index funds. An index fund may choose to put the thousand biggest companies in the world in the index. But you can’t buy Alibaba. You buy Alibaba of the Cayman Islands.
“Now Alibaba is one of the biggest companies in the world, but Alibaba Cayman Islands – the Cayman Islands isn’t even one of the biggest islands in the world. You’re investing in a shell company that invests in another shell company that has a contractual relationship with Alibaba. Does that belong in an index?
“But we do see that China is able to pressure Morgan Stanley and others to include these questionable entities in indexes.”
The IPO of the online Chinese retail marketplace, Alibaba, began trading on the New York Stock Exchange on September 19, 2014. It closed its first day of trading with an increase of 38 percent, giving it a market value greater than Disney or Boeing. Alibaba was the second largest IPO in U.S. stock exchange history. The SEC filing for the Alibaba offering included the following information on the Variable Interest Entity (VIE) structure:
“Specifically, our material variable interest entities are majority-owned by Jack Ma, our lead founder, executive chairman and one of our principal shareholders, and minority-owned by Simon Xie, one of our founders and a vice president on our China investment team where he works on projects related to our China acquisition and investment activities. These contractual arrangements collectively enable us to exercise effective control over, and realize substantially all of the economic risks and benefits arising from, the variable interest entities. See ‘Our History and Corporate Structure — Contractual Arrangements among Our Wholly-foreign Owned Enterprises, Variable Interest Entities and the Variable Interest Entity Equity Holders.’ The contractual arrangements may not be as effective in providing operational control as direct ownership. See ‘Risk Factors — Risks Related to Our Corporate Structure.’ ”